CHAPTER ONE

INTRODUCTION

• Introduction

The profitability of commercial banks is a cornerstone of financial stability and economic development in Cameroon. As financial intermediaries, banks take deposits and extend loans, making their performance crucial for economic growth. The relationship between interest rates and bank profitability is particularly important, as fluctuations in rates can significantly influence banks’ earnings and overall financial health (Nji Atanga, 2023). This project investigates how lending interest rate variations impact the profitability of commercial banks in Cameroon, aiming to provide insights that can aid policymakers and banking institutions in navigating the complex financial landscape.

This study structured as follows: chapter one of the study present background, problem statement, research questions and objectives of the study, hypothesis, significance of the study, scope and organization of the study. Chapter two contains the literature review of study, detailing the roles and functions of commercial banks, factors that affect their profitability, with special attention on interest rate. It also details the factors that determine and cause changes in interest rates. Chapter three presents the methodology used in this study. The data is analyzed using ordinary least square and descriptive analysis. Chapter four addresses the questions proposed for the study, and how the interpreted results address and answer the proposed questions. Finally, chapter five draws conclusions about the study in relation to the research questions.

• Background to study

The banking sector plays a vital role in the economic development of any country, and Cameroon is no exception. Commercial banks, in particular, are essential in mobilizing savings, providing credit, and facilitating payments. However, the profitability of commercial banks in Cameroon has been a subject of concern in recent years. According to a study by Ngwa and others (2020), the banking sector in Cameroon has experienced significant challenges, including low profitability, high operating costs, and increased competition. Similarly, a report by the Bank of Central African States (2020), noted that the profitability of commercial banks in the Central African Economic and Monetary Community (CEMAC) region, which includes Cameroon, has been declining in recent years.

One of the key factors that can affect the profitability of commercial banks is the interest rate. Interest rates can influence the cost of borrowing, the price of loans, and the overall profitability of banks. However, the relationship between interest rates and bank profitability is complex and can vary depending on various factors, including the level of interest rates, the state of the economy, and the specific characteristics of the bank. The first attempt to control interest rate through manipulation of money supply was made by Banque de France in 1847. The latter half of the 20^th century saw the rise of interest-free Islamic banking and finance (Mr. Mohsin S. Khan 01 Jan 1986), a movement that applies the law to financial houses and economy, some countries including Iran, Sudan and Pakistan have taken steps to eradicate interest from their financial systems.

During the 1980s many African, Asian, and European countries have adopted McKinnon and Shaw financial model by eliminating or reducing credit control, giving autonomy to commercial banks, deregulating interest rate, permitting private ownership of banks, free entering into the banking sector, and liberalizing international capital flow. The Nigeria government in 1987 deregulates interest rate as part of a structural adjustment program. (SAP)

The financial system is a complex network of financial markets, institutions, businesses, households, and transactions. According to Merton (2013), the financial system plays a crucial role in facilitating the flow of funds between lenders and borrowers. Similarly, Saunders and Cornett (2018) note that the financial system enables the transfer of loanable funds (credit) from lenders (saving surplus units) to borrowers (saving deficit units).

Lenders, as defined by Mishkin (2016), are individuals or institutions whose current income receipts exceed their current expenditure, resulting in excess funds that can be lent to borrowers. This financial transaction can be carried out directly between lenders and borrowers or semi-directly through intermediaries such as banks and other financial institutions, where a third party is involved. The shortcomings of direct and semi-direct financing have opened doors for third method-financial intermediation, which is done by financial intermediaries.  Over the past years, the list of borrowers has expanded from merchants and governments to include landowners, other banks, industrial firms, and consumers. Banks have faced demand for credits from these new classes of borrowers. Satisfying their demands has led to higher yields but typically increased risk and reduced liquidity, especially mortgage lending, because of its long term maturity.

By almost any measure, the commercial bank is the most important financial intermediary serving the public today. They offer more services than the majority of other financial institutions, which include expanding the money supply by granting credits (loans) to borrowers. They accept deposits from saving surplus units (lenders) and grant it as credits (loans) to saving deficit units (borrowers). Loans and deposits are the major components of the bank’s balance sheet Assets and Liabilities (Horobet et al, 2021). The fee paid by someone for the use of someone else’s money is known as interest. It is received when money is lent and paid when money is borrowed. When the borrower pays off the loan, he has to pay the principal amount he borrowed as well as the amount of interest occurred on that principal. Moreover, when someone gives up the right to someone to spend his money and as reward received some compensation is called interest. By ignoring the interest, investors wouldn’t be interested to postpone their spending as well as lender to lent money since interest gives a significant impact on their profitability (Atanga, 2023)

The capability to predict and to avoid the risk to fulfil the losses due to the arisen risk is essential for the success of banks. The cheapest source of funding for competitive banking institution is profit and it is the major requirement of a banking institution. The rising competition in financial market makes it necessary for the success of banking industry. These key facts are the reasons to focus on the present issue of banks profitability. These key facts are influencing the efficiency and effectiveness of banks to handle their portfolios like assets and liabilities to attain profitability and discover the areas where it might have potential room for increasing their profitability.

In Cameroon, the African development bank is in charge of development and reconstruction plans. But since Cameroon is a member state of the World Bank, the international bank for reconstructions and development also have a role to play. The banking market in Cameroon is oligopolistic and a few banks dominate the market such as BICEC, SGBC, and AFB. Some banks are price taker and others have strong support from the government which includes BICEC and SGBC (Beck, T &. R. A. (2018)). Interest rates in Cameroon is a major instrument of monetary policy with regard to the role it plays in the mobilization of financial resources aimed at promoting economic development and profitability of commercial banks

In 2007, Nigeria interest rate was as low as at 8.0%, it rose to 14.0% (CBN, 2017). Auction markets for government securities were introduced; capital adequacy standards were reviewed upward and the extension of credit based on foreign exchange deposits was banned (Hussainatu; 2008). Nigeria’s interest rate fluctuates over time as the Central Bank was to regulate and supervise all interest rate re-administered. The monetary authority introduced indirect monetary instruments in order to control the interest rate and the rate of inflation. The interest rate has doubled through the period of 2022 and 2025 attaining an average of 27.50% (CBN; 2025). This rapid increase in the interest reflects the central bank of Nigeria efforts to manage inflation and stabilize the financial system. Factors such as fluctuating economic conditions, the introduction of indirect monetary instruments, and adjustment in capital adequacy standards have all played a role in these changes. Additionally, the central bank’s responds to external economic pressures and the ban on extending credit based on foreign exchange deposits have further shaped the interest rate landscape. These measures were implemented to ensure a more stable and robust financial environment in Nigeria.    

The banking sector in Cameroon has experienced substantial changes since the economic liberalization of the early 2000s. The sector comprises both public and private banks, each playing a distinct role in the economy. According to Ngwa (2018), the Central Bank of Central African States (BEAC) regulates monetary policy and interest rates in the economic and monetary community of central African (CEMAC) zone, which in turn affect lending and deposit rates across the country. Lending interest rates are a fundamental aspect of monetary policy, serving as a tool to control inflation and stimulate economic growth. When interest rates are high, borrowing costs increase, which can suppress consumer spending and business investments (Ndon, 2021). Conversely, low-interest rates can encourage borrowing, leading to increased economic activity. The dynamics of interest rates in Cameroon are influenced by several factors, including inflation, government policies, and global economic conditions (Tchamba, 2022). The official rate in the central bank of central African states is the prime lending rate. Cameroon as a member of the CEMAC region actual benchmark interest rate is 2.45% however, the lending interest rate of 4.25% in March 04, 2020 and record a high of 7.50% in December 19, 2024.

The relationship between interest rates and bank profitability in Cameroon is complex, influenced by regional monetary policies and the country’s unique economic context. As a member of the Central African Economic and Monetary Community (CEMAC), Cameroon’s banking sector is affected by interest rate settings by the Bank of Central African States (BEAC). Interest rate fluctuations can significantly impact bank profitability, with higher rates potentially leading to increased interest income but also higher default rates among borrowers. The regulatory environment, shaped by the BEAC’s monetary policies, plays a crucial role in this dynamic. Further research is needed to explore this relationship, including analyzing the impact of interest rate changes on bank profitability in different economic scenarios and examining the role of regulatory policies in shaping the banking sector’s response to interest rate fluctuations.

Empirical studies globally have consistently demonstrated a close linkage between the profitability of banks and changes in interest rates. For instance, an increase in interest rates can boost a bank’s interest income, but it simultaneously exposes the bank to the heightened risk of higher default rates from borrowers (Mouelle, 2023). This dual impact necessitates a deep and nuanced understanding of the precise mechanisms through which interest rates influence bank profitability. The global economic disruptions caused by the COVID-19 pandemic have added an unprecedented layer of complexity to this already intricate relationship. The pandemic led to significant shifts in consumer behavior and exacerbated credit risks for banks. Consequently, comprehending how interest rate fluctuations interact with and affect bank profitability within this new, post-pandemic economic context is absolutely critical for ensuring the continued stability and resilience of Cameroon’s financial sector.

Moreover, the competitive pressures among banks tend to keep interest rates within a relatively comparable range, presenting a significant economic challenge in effectively managing and tracking developments in these rates. Interest rates are not just an external factor; they play a crucial internal role in the profit and loss statements of banks, directly influencing the management of interest components. A pervasive issue in many developing economies, including Cameroon, is the presence of low, and sometimes even negative, real interest rates. Such rates can discourage savings, as the real return on deposits diminishes, while simultaneously stimulating an increased demand for loans. This often leads to a situation where the demand for funds outstrips supply, leaving critical sectors of the economy starved of necessary financing. (Moukam, 2022).

In Cameroon, bank charges are subject to regulation by the Ministry of Finance. The lending rate, for instance, is set at approximately 22% without taxes (an increase from a previous 17%), while exchange rates for both buying and selling typically range from 1.5% to 4%. The maximum deposit rate is capped at 8%, with a base rate of 4.5%. Other transaction charges average around 15% of the transaction amount, and a single borrower’s limit is capped at 45% of the bank’s capital funds. Cameroon’s mixed economic model implies that the banking sector, particularly commercial banks, plays a complementary role in fostering economic growth and development. A primary objective for these banks is to maximize profit efficiently by charging reasonable interest rates. Despite this clear objective, there remains a notable absence of comprehensive empirical studies that can effectively guide policymakers and financial experts in implementing robust and effective reforms concerning interest rates within Cameroon’s financial landscape. This study is specifically designed to address this critical knowledge gap by undertaking a thorough investigation into the effects of interest rates on the profitability of commercial banks in Cameroon. This research aims to provide crucial empirical insights to inform policy decisions and strategic planning within the Cameroonian banking sector.

1.3 Problem statement

The competition among banks has kept interest rates within a comparable range, presenting a significant economic challenge in managing and tracking developments in interest rates (Smith & Johnson, 2021; Wang, 2023). Additionally, interest rates play a crucial role in the profit and loss statements of banks, impacting the overall management of interest components (Garcia & Lee, 2020). Low and sometimes negative real interest rates discourage savings and increase the demand for loans, leading to situations where the demand for funds exceeds supply while critical sectors of the economy remain starved of financing (Adams & Roberts, 2022).

In Cameroon, bank charges are regulated by the Ministry of Finance, with the lending rate set at approximately 22% without taxes (up from 17%) and exchange rates ranging from 1.5% to 4% for both buying and selling (Manga &Ngu, 2024). The maximum deposit rate is capped at 8%, with a base rate of 4.5%. Other transaction charges average around 15% of the transaction amount, while a single borrower’s limit cannot exceed 45% of the bank’s capital funds. The mixed economy of Cameroon implies that the banking sector, particularly commercial banks, plays a complementary role in fostering economic growth and development, with a primary focus on maximizing profit efficiently by charging reasonable interest rates.

Despite this, the greatest desire of commercial banks in Cameroon is to maximize profit efficiently and effectively by charging reasonable interest. Never the less there is a lack of empirical studies that can guide policymakers and financial experts in implementing effective reforms regarding interest rates in Cameroon. This study aims to address this knowledge gap by investigating the effects of interest rates on the profitability of commercial banks in Cameroon.

1.4 Research questions

1.4.1 Main Research Question

What is the effect of interest rate on the profitability of commercial banks in Cameroon?

1.4.2 Specific Research Question

1. How does the interest rate on loans affect the Return on Equity (ROE) of commercial in Cameroon?
2. What is the impact of interest rate on loans on the Return on Assets (ROA) of commercial in Cameroon?
3. How does the interest rate on loans affect the Interest Rate Margin (IRM) of commercial in Cameroon?

1.5 Objective of the study

1.5.1 Main Objective of the study

This study aimed at investigating the effect of interest rate on the profitability of commercial banks in Cameroon.

1.5.2 Specific Objective of the study

1. To examine the relationship between interest rate on loans and Return on Equity (ROE) of commercial in Cameroon.
2. To analyze the impart of interest rate on loans on the Return on Assets (ROA) of commercial in Cameroon.
3. To investigate the effect of interest rate on loans on the (Rate Margin (IRM) of commercial in Cameroon.